Week of the truth about the ECB

The official decision of the European Central Bank (ECB) for a “turn” in monetary policy is expected on Thursday. Already during the last meeting of the Governing Council, in June, the head of the Bank, Christine Lagarde, had announced, for July, the first increase in the key interest rate after 11 years. If what has been announced comes true, within the month we will see an increase in interest rates by 25 basis points, while in September another increase will follow, this time by 50 basis points.

All of this would mean the end of negative interest rates. Already today dozens of banks in Germany – and not only – are withdrawing the “guardian” or other related charges for their depositors, discounting the relevant announcement from Frankfurt, while the rest of the banking institutions are expected to follow in the coming weeks.

Interest rates rising, but when and how?

The vexing question is how quickly the ECB will raise interest rates, since it is “already overdue,” as Gertrude Traud, chief economist at the state bank of Hesse-Thuringia, argues. She estimates that, given the historically high inflation rate of 8%, the situation in the eurozone is “critical” and “since central banks around the world have already raised interest rates, the ECB should also prove that it meets its mission and fights inflation”.

However, it remains controversial, even within the ECB, at what pace the interest rate “jump” will materialize. The governor of the German central bank, Joachim Nagel, who belongs to the “hawks” of Frankfurt, that is, to the devotees of a stricter monetary policy, considers an even greater increase possible, which could, however, stifle economic growth. Another line is followed by the “doves” of monetary policy, warning of an uncontrolled recession, if nothing else because of the protracted war in Ukraine.

25 or maybe 50 basis points?

Carsten Junius, chief economist at Swiss bank Safra Sarasin, would prefer an immediate 50 basis point hike and argues that the ECB does not need to stick so reverently to its previous announcements. But even if this time the rise in interest rates is limited to 25 basis points, says Gertrud Traut, it is important that the currency’s custodians reiterate their commitment to another hike in the autumn. After all, it is assumed that the long-term objective of the Bank is an inflation rate of around 2%, so that the stability of the euro is not endangered.

On the other hand, the guardians of monetary stability know that a sharp adjustment could strangle the economic recovery. “In energy prices we can’t change anything anyway,” says Martin Luke, chief economist at Blackrock’s German subsidiary. “Consequently the prices of other goods should fall.”

With an eye on USA-Italy

Pressure on the ECB is intensifying for the additional reason that the gap with US interest rates is widening. After the June data, which raised inflation to 9.1% on the other side of the Atlantic, it is considered likely that very soon the American Central Bank (Fed) will raise interest rates again by 75 basis points. This development puts even more pressure on the single European currency, which has fallen to absolute parity with the US dollar. Finally, international markets are anxious about the political developments in Italy. Mario Draghi is still prime minister, but not for long, it seems. It is considered possible that early elections will be held in the fall. A victory for the Eurosceptics could cause “significant turbulence” in the markets, says Edgar Walk, chief economist at private bank Metzler.

Brigitte Soltes

Edited by: Yiannis Papadimitriou

Source: Deutsche Welle